Why You Should Avoid the Decade's Top Fund

CGM Focus has completed an incredible decade. Manager Ken Heebner has guided his fund to an amazing 17.9 percent annual return for the ten years ended 2009, a record that places him first among all domestic equity fund managers for the period, and one that surpasses both the S&P 500 and the Russell 1000 Growth index by some 20 percentage points.

So should you add this fund to your portfolio? Best to think twice about that one.

Why? For starters, Heebner's managerial style makes a six year-old on Christmas morning look placid. Since 2000, his fund has had an average turnover rate of 333 percent, meaning that his entire portfolio is essentially changing once every three or four months. That sort of turnover can produce a boatload of tax liabilities for the fund's owners, as it did in 2007, when CGM Focus produced a capital gain distribution of $9.91 per share, 18 percent of the fund's year-end share price. Small wonder that, according to Morningstar, the fund's tax cost ratio for the decade ranks in the bottom five percent of its peers.

Secondly, CGM Focus has an incredibly concentrated portfolio, typically investing in fewer than 25 stocks. Making large bets on a few different firms can pay off handsomely when Heebner is right -- as in 2007, when the fund earned 80 percent. But the flipside is that it can also produce outsized losses, as evidenced by the fund's 48 percent loss in 2008.

This whipsawing performance is clearly evident in viewing the fund's year-by-year performance. In five of the past ten years, CGM Focus has landed in its category's top quartile. In three years, it's been in the bottom quartile. (A stint in each of the two middle quartiles has rounded out the decade.) It is this sort of up and down performance that led FundAlarm's David Snowball to compare Heebner to the Little Girl with the Curl: When he's good, he's very very good; but when he's bad, he's horrid.

But even given those facts, the fund's track record speaks for itself. So why not pile in and hang on for the ride?

Because the evidence is overwhelming that no matter how much you convince yourself that you have the stomach for the roller coaster Heebner will likely provide going forward, you ultimately do not.

According to Morningstar, while CGM Focus was on its way to a 17.9 percent annual return over the past decade, the fund's investors were earning an annual return of -10.8 percent -- a staggering spread of nearly 30 percentage points. In dollar terms, each dollar invested in the fund at the outset and held through 2009 would have grown to $5.19. The average CGM Focus investor, on the other hand, would have seen that dollar fall to $0.32, or just six percent of what the fund ultimately earned.

Much of this gap is attributable to something that's quite common in the fund industry: a fund starting with a low asset base ($69 million, in this case) growing flush as investors rush in after a solid track record is established. But the amazing magnitude of the spread in this case is also the result of CGM Focus investors finding they're not able to tolerate the fund's ups and downs from one year to the next -- jumping in during one of the top quartile years, bailing out when it falls to the bottom, only to (in all likelihood) start the process all over again once performance recovers.

Clearly, buying high and selling low is a sure-fire recipe for wealth destruction, whether the fund you're moving in and out of is producing record-making returns or more mediocre results. So before you become captivated by a superior track record, you'll be well-served to scratch the surface of those returns, and try to honestly assess whether or not you're suited to the manager's investment style.

Sure, it's rewarding -- both to one's ego and investment account -- to find a manager who is able to outperform the market by 20 percent annually for a decade. But on the flipside, it's doubly crushing to have to face the fact that you were able to find a way to turn that performance into mere pennies on the dollar. In such a case, you've lost not just confidence, but money, and, perhaps more important, ten entire years, which are priceless in the pursuit of your investment goals.

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Nathan Hale has spent decades working in the financial services industry, during which he has researched and written extensively about personal investing, the mutual fund industry, and financial services. In this role, he uses a nom de plume because many of his opinions about the mutual fund industry and its practices would not endear him to its participants.